Being Greedy When Others are Fearful

Welcome back to the 5th HYH Newsletter! (Excluding this Advice for Interns guide I posted just to my website)

As many of you know, I’ve had the belief that we are in/on the brink of a recession. During the past 8 months, the absurd tech and crypto bubble has burst (although valuations are STILL too high on some stuff) and a lot of growth focused investors (Hedge Funds like Chase Coleman’s Tiger Global and pretenders (sorry, but this is probably fair for someone promising 40% IRR and 50% GDP growth) like Cathie Wood’s Ark Invest) have been wrecked by the collapse in multiples and forward earnings. Unless you’re overweight energy, you’re probably down YTD (although even energy has cooled back down to earth now too). This sucks and we were probably conditioned to an extent to expect solid equity market returns y/y given how easy the past few years have been. But despite all the market turmoil, and even if there's probably more downside ahead, it’s probably time to start thinking opportunistically (even if it's not time to deploy it yet). But first my disclaimer - All of this is obviously not financial advice. 

Several companies rose from the ashes coming out of the Great Financial Crisis (GFC) in particular, and several savvy investors were able to make career defining trades/deals through being opportunistic af. That’s why I’m looking to provide a rundown of some of the best investing success stories from the past cycle.

There’s some obvious stuff I didn’t include – I'm mainly focused on the ideas people presented to me on Twitter. Obviously, if you bought a decent chunk of Amazon in 2001 and held, you’d be a millionaire. Some of the general, most notable trades that worked out well from the past two recessions were 1) buying the best of the best tech stocks at the bottoms and 2) the sophisticated investors like Michael Burry who were able to short the housing market (as demonstrated in the movie The Big Short).

We’ve had a bit of an uptick recently in the market, but I’m still relatively cautious and think if we are recession bound, then a market downturn has at least a 12-18 month life. This Bloomberg article highlighted the dangers of a bear market rally in the past two cycles:

From a different lens, this Bloomberg article highlighted how long bear market rallies can go on for:

I would think the U.S. stock market would somehow soar past previous all-time highs (although remember, the Nasdaq took 14 years to recover back to all-time highs, so *not all* tech may come back even if the broader market does). There's a bunch of companies from the Tech Bubble and GFC that didn't make it out alive, were sold at a big discount, or are now a shell of their former self.

This might be a better way of thinking how far we could go - CNBC had a very good chart noting that the median decline in the S&P 500 during a recession is -27% (average is -32%).

I don’t proport to know much, but I think the last two recessions showed that the downturn in the market takes time and that buying the dip aggressively too soon was a bad idea. Every cycle is going to be different, but I think it’s worth having this CNBC chart in your back pocket..as well as closely monitoring what the Fed wants to do. If the Fed suddenly decides to cut rates or re-initiate QE…this could be a big change in tone that could support higher valuations.

We'll have to see how it plays out, and hopefully learn a ton from it, but let’s start diving into some specific stories:

Sheldon Adelson’s YOLO, tax loophole LVS trade: Sheldon Adelson, who passed in 2021, was an American businessman, best known as the founder, chairman, and CEO of Las Vegas Sands (LVS) Corporation, a giant casino company. Naturally, casinos are relatively cyclical and were impacted dramatically during the GFC. Las Vegas Sands was overlevered and nearing bankruptcy, with the stock plunging to under $2/share in early 2009. In March of 2009, Adelson acquired >12.5mm shares of LVS, totaling a $37.4mm purchase. As the economy recovered, the stock rebounded to mid 50s/share within a few years. Obviously, buying the dip during the GFC sounds great….but wait there’s more! Adelson was able to avoid taxes entirely on this trade. A tax shelter, a grantor retained annuity trust (GRAT) made it easy for Adelson to bypass estate and gift taxes of 40%, creating quite the windfall for Adelson’s six children. During this plunge, Adelson plowed money into new GRATs, with roughly 30 trusts in place at the time… It was estimated in 2012, that >$10bn had been passed through GRATs, avoiding gift taxes of $2.8bn. Not only did Adelson nail the bottom, but he nailed the tax code.

Next up - David Tepper, the founder and president of Appaloosa Capital, who built up a $16.7bn net worth:

Tepper is also known for buying the Carolina Panthers a few years back. That investment doesn’t seem to be going so hot…(what a QB carousel of Teddy Bridgewater/Sam Darnold/Cam Newton 2.0/Matt Corral, and now Baker Mayfield), but obviously he made a killing buying financials during the GFC. Tepper went long financials at the bottom of the GFC and Appaloosa ended up making $7bn, with Tepper reportedly personally making $4bn.

Tepper was reportedly able to scoop up preferred equity and equity stakes in AIG, Bank of America, and Citigroup for cents on the dollar – with BofA and Citi prefs at 12 and 19 cents on the dollar respectively, and AIG CMBS at 9 cents on the dollar. Tepper made a significant return on AIG – buying $100mm of commercial paper for 30 cents on the dollar. When AIG got bailed out, the paper traded back to par.

So hey, the Panthers may not be looking so hot (although given population trends favoring the Carolinas, I’m sure he’ll be validated in the long run), but he really nailed the bottom in financials during the GFC.

John Paulson shorting housing going into the GFC, then going long distressed credit and real estate in 09: 

John Paulson, a billionaire hedge fund manager and founder of Paulson & Co did a phenomenal job trading into and out of the GFC. During the housing market collapse, Paulson shorted about $25bn of securities and generated a $15bn profit, pocketing $4bn of that for himself. Paulson initiated short positions and bought CDS contracts of subprime mortgages from institutions such as Lehman Brothers, Bear Stearns, New Century, Fannie Mae, Freddie Mac, Citi, Washington Mutual, and IndyMac.

Paulson nailed the short side – but he also wasn’t afraid to shift gears. In early 2009, Paulson moved to the long side, taking an investment in CBRE, a global real estate services firm. Paulson launched a real estate PE fund in March, 2009, with the fund’s investment focus zoned in on residential and commercial opportunities.

A $4bn dub is quite personal haul for Paulson, although his HF’s assets have fallen from a peak of $38bn in 2011 to less than $11bn today and it looks like, based off several news articles, that he should’ve invested in a pre-nup.

Leonard Green giving Whole Foods a private equity solution:

Leonard Green, a U.S. private equity firm, took a nice opportunistic bet on Whole Foods near the bottom of the GFC. Leonard Green invested $425mm (which converted into a 17% common equity ownership stake) in Series A preferred equity in Whole Foods in November 2008. This occurred when Whole Foods was trading at a seven year low of $10/share, driven in part by the challenging economic environment, but also due to over-expansion and its acquisition of rival, Wild Oats. The pref earned a 8% annual dividend, but was convertible to common shares at $14.50/share.

Company performance and the economic background recovered, so in December 2011, Leonard Green filed to sell their remaining equity position (7.7% of the total company), with shares trading at $90/share around that time (a $746mm gain). Prior to this, Leonard Green had sold 15.7mm shares for a $540mm gain since February 2010. Not bad, especially since Amazon bought Whole Foods for $13.7bn (~$42/share) in 2017…

Apollo taking over LyondellBasell, a nice, distressed debt play:

LyondellBasell was founded in Dec. 2007 through Netherlands based chems company Basell Polyolefins acquiring Lyondell Chemical, a U.S. based producer of ethylene and propylene oxide, for $12.7bn at the top of the cycle. This deal was spearheaded by Len Blavatnik, a Ukrainian-born America who had been consolidating Chems companies to form Basell in the first place.

Ofc, December 2007 wasn’t really a good time to place a deal. At that time, the credit market was already starting to unravel and Citi was stuck with $43bn in underwritten bank loans it couldn’t syndicate, lol. Apollo co-founder Josh Harris spearheaded this effort, buying a total of $2bn in LyondellBasell bank debt from Citigroup (who was notttt in good shape in ’08). Initially, Apollo paid roughly $1.4bn for LyondellBasell paper for 80 cents on the dollar. As the situation deteriorated, Apollo dollar cost averaged in the 60 cents to 20 cents range as the Company reached bankruptcy, kicking in $600mm for a $3.2bn DIP, and driving Apollo’s average cost on the bank debt to roughly 50/60 cents on the dollar. LyondellBasell filed for C11 bankruptcy in January 2009, emerging in April 2010. By the time Lyondell filed, Apollo was able to convert their debt into a large equity stake.

Shares of Lyondell rallied 500% following its bankruptcy and in November 2013, Apollo realized a $9.6bn profit on exiting LyondellBasell through selling their final amount of shares via a stock offering. Their Nov. 1. 2013 stock offering of 15mm shares priced at $74.10/share. This was quite the homerun - a $2bn investment in 2008 became a $14bn investment by 2013. A homerun like this really spurred fundraising at Apollo, and was quite the (Caesar Palace) coup.

Institutions accelerating buying residential real estate: This just doesn’t seem like a game that’s fair for the individual investor, hell, we just want a nice suburban home! But an obvious winner coming out of the GFC, were institutional investors/private equity firms that were buying up homes on the cheap. In fact, by 2016, 95% of Fannie Mae and Freddie Mac’s distressed mortgages were auctioned to Wall Street investors.

It is estimated that institutions own roughly $60bn worth of housing properties. This wasn’t really a phenomenon until after the GFC, with several SFR investors diving into Phoenix, Atlanta, Vegas, Miami, the Carolinas, etc. Some of the biggest guys out there include Invitation Homes, American Homes 4 Rent, Blackstone, and Starwood. It was noted in October 2012 by Blackstone CEO Steve Schwarzman that the Company was spending $100mm a week buying homes while a lot of us were still reeling from the GFC. In the fourth quarter of 4Q21, institutional investors bought 18.4% of all homes in the U.S., ~80k homes at $50bn in total purchase value. The chart below from Redfin demonstrates how significant this trend has gotten, especially in lieu of lower building activity following the GFC spooking the hell out of even the largest builders.

Look at that market share grow! Here is the full deck from the National Association of Realtors for anyone who wants to dive in later.

Look at where the bulk of home buying has been playing out too – in markets where a lot of people are migrating to! Fun stuff!

I hate to say it, but this is going to remain an increasingly problematic trend within the U.S. Obviously, a lot of Wall St. and Software folks will be able to buy homes, but generally Gen Z/Millennials are having a harder time due to higher debt levels and higher pricing of average day goods that makes saving up more challenging. This ofc, is coupled with the fact that houses were significantly lower priced decades ago, but hey, congrats to the boomers on their cheap housing equity. This situation doesn’t seem sustainable, and maybe getting the SFR giants to knock it off/regulating them more is actually bi-partisan? We’ll see what happens, but def not gonna wait on the legislative branch to save me.

Daniel Loeb buying Chrysler and Delphi credit:

Daniel Loeb, the founder of the Hedge Fund, Third Point (based off of his favorite surf break in Malibu) has quite the track record. Loeb nailed the bottom, and wrote back in April 2009 that he was starting to become less pessimistic about the economy. As a result, Loeb bought distressed debt from Ford, CIT, and Delphi. By the end of 2009, Third Point was up 45% y/y.

This was highlighted to me as a solid trade – although Loeb was down 32% and 37% in 2007 and 2008 respectively.

That concludes this newsletter! Personally, the Apollo and Leonard Green deals were my personal favorites to dig into, as I think there’s going to be an opportunity to find different iterations of LyondellBasell and Whole Foods this cycle.

Let’s circle back in September (taking August off for the Newsletter so I can enjoy the best weather of the year).

Best,

HYH